Overcoming your wealth-destroying instincts
At the final round of acsis/Personal Finance Financial Planning Club meetings for the year, acsis chief executive Andrew Bradley focused on your base instincts – such as fear – and how these should be tamed if you want to be a successful long-term investo
Investment markets perform well over time, but many investors fail. The reason is that many investors destroy their own potential wealth through their behaviour, Andrew Bradley, the chief executive officer of financial planning company acsis told the recent round of acsis/Personal Finance Financial Planning Club meetings.
Bradley says that despite the fact that our generation, on average, is enjoying the highest level of affluence ever, has much better education than previous generations and hence much better financial literacy, and a huge range of financial products and providers from which to choose, most South Africans are chronically under-insured, under-saved and under-invested.
The key reason, he says, is our behaviour and psychology.
South African unit trust funds have shown a long-ter m average retur n of 9.4 percent a year over rolling five-year periods, but the average unit trust investor has ear ned only 4.1 percent a year over the same rolling periods, he says.
This is because investors tend to invest and then pull out at the wrong time in the investment cycle. When investment markets are falling they tend to succumb to growing concern, which leads them to disinvest at or near the bottom of the market’s downward cycle, Bradley says.
They then watch the market’s tur naround with contempt and regain sufficient confidence to enter the market again only when it is at or near its peak, he says.
This means they sell their investments at the bottom of the market, when prices are at their lowest, and invest again when prices are high or near the top of market.
The result is that, on average, they enjoy much weaker performance than that produced by a fund that stays invested in the market throughout its cycles.
In the same way that poor physical health is often caused by inappropriate behaviour, so too is poor financial health, Bradley says.
The drivers of our bad behaviour are factors such as peer pressure and status, uncertainty and a lack of control, the desire to live for today, an aversion to suffering losses, overconfidence, and using price as a proxy for quality (we are prepared to pay higher prices because we think it means we will get quality, but this isn’t always the case with shares).
Bradley gave an example of an investor who destroyed his own potential wealth by panicking at the beginning of this year as a result of the impact of the credit crisis on the markets (See Example 1, right).
He says that while many people destroy their wealth by moving in and out of markets at the wrong time (See Example 2), not staying invested for long enough can have the same effect.
The longer you stay in an investment, Bradley says, the more stable your return is likely to be (See Example 3).
Anyone who invested between just over four and 15 years ago and has remained invested has enjoyed an average annual return of 15 percent or more, he says. Over shorter ter ms, however, retur ns are lower. (See top graph).
Many people think they can time the markets, investing when the market is going up and disinvesting when it is falling. But they usually destroy wealth when attempting to do this (See Example 5).
Bradley says the problem with timing the market is that you don’t only need to know when to get out of the market, but when to go back in.
Even experienced fund managers cannot make these calls with accuracy, he says.
About judging the best time to go back into the market, Bradley says you should consider the scenario in Example 4. This shows how waiting for signs of a recovery before you reinvest can result in your buying in at a higher price and missing much of the benefit of the upturn.
Bradley says some people get market timing right once but hardly ever twice. It is easier, he says, to forecast the weather.
It is much better to harness the power of the markets by staying invested in them for the long term, Bradley says.
Our brains are backward-looking, pattern-seeking systems, while markets are forward-looking pricing systems, Bradley says. You need to make sure your backward-looking, pattern-seeking brain looks at the right pattern, he says.
Looking at the market’s performance over the past 10 or 20 years shows a general upward trend in prices. A two-or even a five-year view, however, may show losses and could scare you off investing (see bottom group of four graphs).
To realise your full potential you need to have goals and strategies and the confidence and sense of control that allows you to take the appropriate action to follow those strategies, Bradley says.
He says that sometimes we destroy wealth without knowing it, and a financial planner who is prepared to advise you, guide you and hold your hand through the scarier investment times can play a critical role in helping to prevent undesirable behaviour.
A good planner will help you identify behaviour that can destroy wealth and coach you through it so that you can regulate yourself and develop desirable behaviour that eventually becomes “embedded and unconscious”.
WORDS OF WISDOM
Bradley concluded his presentation with the words of Warren Buffett, who is regarded as one of the world’s most successful investors. Buffett says: “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
Andrew Bradley of acsis